Reform of exchange controls Part II:

Bringing exchange controls to the

permanent law book

Tuesday, 2 May 2017

The Central Bank implements ECA as the agent of the
Government and for that purpose has to create a separate
department called the Exchange Control Department
Exchange controls to fight a war

In Part I of this series (available at:

http://www.ft.lk/article/610886/Reform-of-exchange-controls--
There-is-a-need--but-do-it-correctly-%E2%80%93-Part-I), it was
presented that Sri Lanka which had enjoyed a control free
environment from time immemorial had clamped exchange
controls on its citizens in 1939.

The objective had been to prevent the foreign exchange resources

of the country from falling into the hands of the enemies of the
British Empire which fought a war against the Germans in Europe
and against the Japanese in the East. Its coverage was limited to
non-Sterling area countries which had not used the Sterling Pound
as its currency or as its reserve asset.

But it was a temporary measure

By all means, the exchange control was a temporary measure

introduced during the wartime and was expected to be lifted at
the conclusion of the war. Yet, the circumstances that prevailed
after the war, it was pointed out, even after the independence
from the British rule in 1948, the country was destined to
continue with exchange controls. This time, the coverage was
universal that included even the Sterling area countries.

Compelling reasons for continuing with exchange controls

Several reasons could be attributed to the change of policy in this

manner. First, the British Raj which also had introduced exchange
controls in 1939 had made it a permanent law in 1947 by
enacting its own version of the Exchange Control Act.

Second, India whose currency had been kept by Sri Lanka as the
reserve asset when it issued rupees to the system under the
Currency Board system had also introduced exchange controls
after independence in 1947. Thus, the example set by the two
countries placed Sri Lanka on high moral grounds to continue with
exchange controls.

Third, both Britain and India froze Sri Lankas foreign assets which
had been kept with them under exchange controls. As a result,
though Sri Lanka had a massive amount of foreign reserves, it
was practically starved of foreign currencies to even to continue
with the prevailing import programme. They were released back
to Sri Lanka only after deliberate negotiations were conducted in
London and New Delhi and even then, in small instalments.

Fourth, there was a fear that the accumulation of foreign reserves

by the country through strict exchange controls and the increase
in the rubber prices in the international markets could reverse
after the country and the world reverted to the normal situation.
All these were compelling reasons for Sri Lanka to continue with
exchange controls after independence and make them a
permanent law in 1953 by enacting its Exchange Control Act or
ECA.

Restrictions on citizens

First of all, exchange control means, in economic terms, two

restrictions on citizens behaviour. In the first case, citizens who
have earned foreign currencies through hard work are prevented
from using them according to their choice. For instance, an
exporter or a migrant worker who has earned foreign currency is
prevented by law from using his or her hard earned income to
buy, say, a motor car of his choice from another country.

Second, citizens who have earned local money, again through

hard work, are prevented from using it for consuming goods and
services produced in other countries by converting rupees into
foreign currencies. For that, they need to get the approval of a
public authority, in this case the Controller of Exchange, who is
appointed specifically for this purpose by the government. The
reasons usually adduced by governments for clamping exchange
controls on citizens are as follows.

Belief that citizens interests are against nations

interests

It is argued that, though citizens earn foreign currencies through

hard work, such earnings are a national asset which should be
carefully used for the prosperity of the nation. The irony is that
the nation is defined here as a collection of people in the country
which is made up of exactly those citizens. Then, it boils down to
the question of the appropriateness of a choice being made
individually as against a choice being made collectively. In this
instance, it is believed that citizens individually cannot make this
choice to maximise the nations interests because their personal
interests might be at variance with those of the nation.

Governments in this case, politicians in power and bureaucrats

who support them think that they are in a better position to
demarcate the boundaries of national interest than private
citizens. Having demarcated them, they say that they have the
right to declare anything that does not fall within that boundary
as moves made against the nations interests. From this line of
arguments, the governments derive the justification for
introducing exchange controls in their respective countries.
Exchange controls are a violation of property rights

But from the viewpoint of property rights, exchange controls are a

nationalisation of property rights of citizens. In the case of an
exporter or a migrant worker, the foreign currencies earned by
such parties belong to them. Therefore, at his or her choice, such
foreign currencies could be sold to a commercial bank for local
money or used for buying goods and services from other
countries.

Exchange controls frown on the latter but have no objection to the

former. In fact, they promote such sales because the nation,
according to them, has access to them for whatever the purpose
they think suitable. But then, the ownership of those currencies
now gets transferred to the bank in question which has in turn
paid value for them out of its own resources. If it cannot use it for
sale to customers and make money, there is no reason for banks
to buy foreign exchange sold to them by their customers. But
exchange controls restrict their use by the new owner using
exchange controls. Thus, private citizens are prevented from
using what they own and restrictions imposed on them in this
regard amount to nationalisation of private property.

But long term effects are disastrous

It may appear from the surface that such a system is beneficial to

a nation. If the country does not own sufficient foreign exchange
to meet its requirements, it could supply itself with the necessary
foreign currencies by preventing their free use.

However, a good economist as opined by Frederic Bastiat in 1850

is one who will see the effects of a policy today as well as in the
future. If anyone who sees only the visible effects, he is a bad
economist. When looked at from this view, it is clear that though a
country may get benefits immediately via exchange controls, as
time passes, it would stands to lose. Thus, an economist with
foresight will not make that choice.

A one-way door to a birds cage

This can be explained by drawing the analogy of a birds cage. If

the door of the cage is kept open, birds can come and go freely
without any fear of being trapped inside the cage. However, if it is
closed after they fly in, they as well as those outside immediately
perceive that it is a trap and once a bird had gone in, it cannot get
out. Therefore, it discourages new birds to fly in. It leads to the
consequence that the number of birds that would fly into the cage
is limited and the birds cage would not expand.

An economy too is destined to stagnation if it has prevented

citizens from using their hard earned money according to their
choice. It may nationalise them today and enjoy the spoil. But it
will not have anything to nationalise tomorrow because no one
would produce something which it can nationalise.

Bringing ECA to permanent law book

It is in this background that ECA was enacted in 1953. The

consideration by authorities was that they have a shortage of
foreign currencies and therefore, the limited availability should be
strictly controlled by suppressing private choice. Instead,
bureaucratic choice was introduced.

The salient features of ECA are as follows.

Salient features of ECA

The Central Bank implements ECA as the agent of the
Government and for that purpose has to create a separate
department called the Exchange Control Department. The officer
in charge of the department, designated the Controller of
Exchange, has to perform his duty under the general supervision
of the Governor who in turn has to consult the Minister of Finance
for directions. The Minister can make regulations to facilitate the
carrying out of the principles and provisions underlying ECA
subject to final approval by Parliament.

Ministers power to designate commercial banks as

authorised dealers

To function as an intermediary between citizens and the Central

Bank, the Minister of Finance is empowered to appoint any
commercial bank as an authorised dealer in foreign currencies
and gold. Gold here means not gold jewellery but gold coins and
bullion which perform the function of money in an international
setting. Restrictions have therefore been imposed on all citizens
to deal in either foreign currencies or gold which only authorised
dealers have been permitted to do.

Accordingly, all citizens have to get the approval of the Central

Bank to buy, borrow or accept, sell, lend or exchange foreign
currencies or gold coins or bullion in as well as outside Sri Lank.
They can do these deals only with authorised dealers.
Accordingly, anyone who holds foreign currencies or gold is
required to sell it to an authorised dealer at a price determined by
the Central Bank. It has further been provided for that citizens
cannot make payments too to those outside Sri Lanka without the
banks approval.

Prohibition to issue securities to raise foreign loans

Issuing securities for the purpose of raising foreign capital by local
businesses has been a normal commercial activity. But ECA has
prohibited the citizens to issue such securities except with the
permission of the Bank meaning that they have to obtain the
approval of Exchange Controls for that purpose.

Prohibition of export or import of currencies and gold

ECA has also prohibited citizens to import or export of currencies

and gold except with the approval of the bank. This prohibition is
then extended to goods which cannot be exported from Sri Lanka
without the approval of the bank as determined by the Minister of
Finance. In instances where citizens have disposed of foreign
exchange to buy property outside Sri Lanka, ECA has provided for
the Secretary to the Ministry of Finance to direct those involved to
sell such property. According to ECA, such property should be
assigned to the Deputy Secretary to the Treasury who in turn
should pay the net proceeds of the sale to the Treasury.

Powers of the Central Bank and the Minister of Finance

As a bureaucratic organisation, the Central Bank has been

empowered to make decisions with regard to applications made
by citizens for approval of transactions which have been
prohibited under ECA. If it is a refusal by the Central Bank, the
aggrieved party could make an appeal against such decision to
the Minister of Finance within 10 days. In this connection,
draconian powers have been vested with the Central Bank and
the Minister of Finance with regard to such decisions and appeals
against decisions.

If an aggrieved citizen has not made an appeal to the Minister

within 10 days, then it is tantamount to admitting that the Central
Bank has made the correct decision. If an appeal has been made
and the Minister has rejected the appeal, then the original
decision made by the Central Bank as well as the subsequent
decision made by the Minister is to be considered as final and
conclusive and cannot be challenged in any court of law. Thus,
without judicial review, a public bureaucracy and a politician have
been given discretionary powers that can at times be draconian
from the viewpoint of the citizens.

Foreign exchange violations are criminal offences

Foreign exchange violations have been made criminal offences

under ECA. Accordingly, those who are found guilty of violating
the provisions of ECA are subject to imprisonment or fine or both
such imprisonment and fine. However, before the commencement
of the prosecution of an alleged party in courts of law under ECA,
the Central Bank may impose a fine on him. However, if the
violation involves foreign currencies or gold, then, the Central
Bank may impose a fine up to three times of their value. Anyone
who is aggrieved once again can appeal to the Minister of Finance
within 21 days.

The Minister has powers to confirm, reduce, increase or annul the

penalty imposed by the Central Bank. Once such determination is
made, the aggrieved party cannot seek redress through the court
system of the country. The provisions are in the opposite; that is,
the Central Bank has powers to recover what has been finally
determined by the Minister of Finance by prosecuting him in
courts of law. This is where ECA has become draconian and
contributed much to dissatisfaction of those who seek to invest in
the local economy or export goods to foreign countries. The
longer it is kept in this form, the more it becomes a birds cage of
which the door has only a one way entry; that is, birds can go in
but cannot get out.
The next part will look at whether the proposed amendment has
addressed these issues.

(W.A Wijewardena, a former Deputy Governor of the Central Bank

of Sri Lanka, can be reached at waw1949@gmail.com.)
Posted by Thavam